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New SDNY Choice on Administrative Precedence for Executory Contracts

To encourage events to transact with debtors in chapter, the Chapter Code in company bankruptcies gives highest precedence to “administrative bills,” which embody “the precise, essential prices and bills of preserving the property.”  11 U.S.C. § 503(b); id. § 507(a)(2).  Part 365 of the Chapter Code permits the belief or rejection of any executory contract—a contract during which the events have ongoing duties of efficiency to one another when a chapter case is filed—and gives that if the debtor rejects the contract, such rejection is handled as a breach occurring “instantly earlier than the date of the submitting of the petition.”  11 U.S.C. § 365.  As a result of part 365 treats legal responsibility from such a breach as arising pre-petition, it’s not handled as an administrative expense and is often a basic unsecured declare.  The mixture of those provisions subsequently raises a query: what occurs if there may be an ongoing executory contract which, in the course of the chapter case, doubtlessly gives advantages to the property, however then is rejected by the debtor?  Does legal responsibility for breach on this circumstance have administrative precedence?  This query was addressed in Finance of America LLC v. Mortgage Winddown LLC (In re Ditech Holding Corp.), 21-cv-10038 (LAK), 2022 U.S. Dist. LEXIS 172793 (S.D.N.Y. Sept. 23, 2022).

Finance of America Income LLC (“FoA”) is a reverse mortgage lender.  It retained Reverse Mortgage Options, Inc. (“RMS”), a mortgage servicer, to subservice sure loans, underneath the phrases of three agreements.  The primary settlement was entered in March 2011, and expired on March 19, 2018, however the events executed a sequence of successive extension agreements, extending it by March 31, 2019.  The opposite two agreements gave FoA a month-to-month renewal choice, which it exercised by February 2019, for the second settlement and thru September 2019 for the third settlement.  RMS filed a chapter 11 petition on February 11, 2019.  After the petition was filed, FoA and RMS entered into a number of extra extensions of the March 2011 settlement, the final of which expired on September 30, 2019, when RMS’s chapter 11 plan of reorganization took impact.

On November 11, 2019, FoA filed a proof of declare in search of administrative expense precedence for damages allegedly ensuing from RM’s breaches of the agreements between the date of RMS’s chapter petition and the date the plan grew to become efficient.  The plan administrator filed an objection, and the chapter court docket granted the objection, discovering that the post-petition extensions weren’t new contracts as a matter of New York legislation, claims primarily based on rejected pre-petition contracts come up pre-petition, and the alleged breaches at problem had been inside FoA’s “truthful contemplation” on the time of the contracts.  FoA appealed.

The district court docket vacated the chapter court docket’s ruling.  First, the district court docket rejected the chapter court docket’s reliance on state legislation to find out whether or not the extensions had been new contracts.  The district court docket held that when the declare arose was ruled by federal legislation, and the suitable federal-law check was whether or not the breaches had been throughout the events’ “truthful contemplation” once they entered the underlying subservicing agreements.  Second, the district court docket held that as to the primary settlement, the danger of breaches after April 1, 2019 was not throughout the truthful contemplation of the events on the time of contract, as a result of the efficiency obligations underneath the primary settlement would have expired on March 31, 2019 had been it not for the post-petition extensions.  The court docket reasoned that excluding claims for breaches after April 1, 2019 would contravene the aim of part 503(b), as a result of it might take away the inducement for a debtor’s counterparties to increase a contract benefitting the property after a chapter petition is filed.  As such, the court docket held that FoA’s breach of contract claims for breach of the primary settlement had been eligible for administrative precedence to the extent they represent “precise, essential prices and bills of preserving the property.”

The court docket utilized a unique evaluation to the second and third agreements, which weren’t prolonged by mutual settlement however by the train of FoA’s unilateral rights underneath the agreements.  As to those, the court docket held that it was foreseeable on the time of contracting that FoA might prolong RMS’s obligations by the post-petition interval, so FoA’s breach of contract claims underneath these two agreements weren’t eligible for administrative precedence.  Nevertheless, the court docket additional held that FoA’s quasi-contract claims could also be eligible for such administrative precedence, counting on a line of circumstances holding that administrative precedence is out there for claims arising from a debtor’s election to obtain a claimant’s items or companies underneath a contract post-petition.  The court docket clarified that in gentle of the final precept that statutory priorities in chapter are narrowly construed, for administrative precedence to be accessible the claimant have to be induced to offer a profit it might not in any other case have offered; mere receipt of advantages is inadequate.  The court docket left it to the chapter court docket on remand to find out whether or not any of FoA’s claims have administrative precedence underneath this customary.


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